With all the attention it’s gained over the past year and the frothy trading seen in sustainable stocks, some warn that a green bubble is forming. But even though the records were set in 2020, it’s important to recognize ESG isn’t really an overnight sensation.

The idea of putting capital to work to address ESG issues central to socially responsible investments can be traced back to the environmental movement of the 1970s and has evolved from negative screens to a wide range of strategies for achieving both financial and non-financial results.

Growth today, however, is not driven solely by investment objectives. Asset owners and asset managers are facing external pressures both from regulators pushing the industry to enact more sustainability measures and from investors demanding more sustainable investments.

On the policy side, the European Union has upped the ante with the corporate reporting guidelines requiring listed companies to publish a non-financial statement of environmentally sustainable economic activities. The UK has implemented mandatory climate-related disclosures. Regulators in Singapore have set guidelines on environmental risk management. France has established mandatory ESG reporting for asset managers. And most recently, the EU implemented the Sustainable Finance Disclosure Regulation requiring asset managers to disclose ESG metrics for all products regardless if they’re labeled ESG or not.

 

United States
Regulatory Measures

Adopted

Department of Labor rule on Financial Factors in Selecting Plan Investments

Under discussion

Non-financial reporting standards for corporates

EU Green Bond Standard

ESG data & ratings

Sustainable corporate governance

United Kingdom
Regulatory Measures

Adopted

UK Stewardship code

Under discussion

Mandatory climate-related disclosures (TCFD-aligned)

UK Green taxonomy

France
Regulatory Measures

Adopted

Mandatory ESG reporting for asset managers (so-called “article 173”)

ESG fund names and marketing communications

Europe
Regulatory Measures

Adopted

Disclosure framework

EU Taxonomy

Under discussion

ESG product distribution rule

ESG risk integration

EU Ecolabel for funds

Future developments

Non-financial reporting standards for corporates

EU Green Bond Standard

ESG data & ratings

Sustainable corporate governance

Singapore
Regulatory Measures

Adopted

Guidelines on Environmental Risk Management & disclosures

Hong Kong
Regulatory Measures

Adopted

SFC Guidance on green funds

Under discussion

Climate Risk Requirements for Asset Managers

Japan
Regulatory Measures

Adopted

Revised Japan Stewardship Code

More professionals adopt ESG
The convergence of these factors is central to higher levels of adoption among professional investors. Our data shows that between our 2019² and 2021³ outlooks, the percentage of institutional investors implementing ESG rose by 18%, climbing from 61% to 72%.

Fund selectors who manage investment platforms at private banks, broker/dealers and other organizations also reported higher levels of adoption, with the number implementing ESG rising from 65%⁵ to 77%⁶ over three years.

Financial advisors who represent many of these platforms provide an idea of just how much individuals have actually invested in these strategies. Globally, advisors report that 16% of client assets are invested in ESG. Those countries with the highest level of investment include Germany, where advisors say 36% of client assets are invested in ESG, France where it’s 29%, and Switzerland where it’s 27%.⁷

Future holds more growth
Fund selectors are likely to believe those numbers will increase, as 86% of those surveyed plan to maintain or increase their ESG offering – only 2% plan to trim. This is likely to be amplified with the focus on model portfolios, as 64% say their firm will add ESG models in the next 12 to 24 months.⁶ So while ESG got more attention during the past 12 months, it already had momentum. ESG was primed for growth, and investors of all types found clearer motivation to drive their decisions.

I want to make a positive social impact with my investments.

Global Average

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I want my investments to match my personal values.

Global Average

^%81^%

Generation

Asset Level

Generation

Asset Level

In terms of determining if they’re implementing ESG to be a better investor or make a better world, the answer from institutional investors appears to be “yes.”³ But not long ago the answer may have been more like “whatever.”

Since first asking institutional investors about their motivations for implementing ESG strategies in 2014, we have seen a significant evolution and enlightenment in their views. Seven years ago, almost half (48%) of those surveyed said ESG served mostly as a PR measure.⁸ In 2015, institutional teams most frequently said they implemented ESG because it was prescribed by their organization’s investment policy statement, or IPS (31%). And while just over one-quarter thought it might also help them minimize headline risk, few (15%) saw the potential for better risk-adjusted returns. Fewer still (10%) saw alpha potential.⁹

In the past six years, the language of ESG has become clearer and started asking the question in a different way, offering “aligning assets with organizational values” as an option in our survey. This is what 57% of institutions say is the reason they implement ESG in 2020. Even still, one-quarter say it’s because the investment policy statement (IPS) requires them to, making ESG sound like something they have to do rather than seeing it in terms of organizational objectives.³

Beyond the values alignment, 35% also say ESG helps influence corporate behavior, which can answer both sides of the better world or better investor question. Influencing corporate behavior can be as much about getting companies to perform better on ESG issues as encouraging them to improve financial performance. More than a quarter (26%) also see ESG as a way of helping to make a better world; a stronger investment narrative is emerging.³

Most significantly, sentiment is shifting on the alpha potential of ESG: In our 2015 survey,⁹ half of institutions said there was alpha to be found in ESG. Today, six in ten (62%) say there is. More than one-third of institutions (34%) say ESG helps minimize headline risks, and they’re more likely to say it produces higher risk-adjusted returns than in 2015 (29% in 2020 vs. 15% in 2015).³

Give the people what they want
Seven in ten fund selectors also see alpha potential for ESG, but their motivation for expanding its use is even clearer – clients want it. Six in ten (61%) say investor demand is driving their adoption of ESG. Values also factor into the decision, as more than half (55%) implement ESG for better alignment. Another 35% say it’s part of a firm mandate.⁶

The need to address client values cannot be underestimated. In fact, 76% of the individuals in our 2018 investor survey said it was important to align their assets with their personal values – including 27% who say it is very important.¹⁰

Fund selectors cite a number of factors contributing to increased demand from clients, but growing social awareness (75%) tops the list. Half owe it up to ESG becoming more mainstream, and four in ten (42%) say it comes down to investors looking to be part of the green economy. Concerns about climate change (36%) and changing client demographics (27%) also factor into the equation.⁶

ESG is also factoring into investment process for a large number of fund selectors. More than three-quarters (77%) say ESG factor analysis is integral to sound investing, and half (48%) go so far as to say it’s as important as fundamental analysis.⁶

More than three-quarters of fund selectors (77%) say ESG factor analysis is integral to sound investing.

A growing number of financial advisors are also beginning to see an investment role for ESG, including six in ten who cite alpha potential. This includes 79% of advisors in Italy, 76% in Spain, and 73% in France. Globally, another 57% see it as providing an added layer of risk management to client investments.⁷

With an increasing number of selectors and institutions adopting ESG practices, it’s no wonder that 59% of advisors overall (84% in Italy, 75% Germany, 70% France) believe ESG will become a standard practice within the next five years.⁷ As it does, all players will need to consider which strategies can best address their ESG objectives.

Not only has the number of professional investors implementing ESG strategies grown considerably, they are also deploying a wider range of strategies, which allows them to address a wide range of objectives.

Integration
ESG integration is most frequently deployed by institutions³ (48%) and fund selectors⁶ (54%). In this approach, they take into account ESG issues that can materially affect company performance in their analysis. Ultimately, the goal is to identify risks and opportunities that may not show up on the balance sheet.

Yet even as large numbers of professionals practice integration, they still have questions. More than half (53% of institutions³ and 55% of fund selectors⁶) believe that companies with better ESG records can generate better returns. But given the wide range of factors that can be considered under ESG, determining which ones matter poses a challenge. In fact, almost three-quarters of institutions³ (74%) and two-thirds of fund selectors⁶ say it’s hard to know which data is material to investment analysis.

There are many pathways to ESG investing – What is the investor trying to achieve? Matching values? Having an influence on companies or an impact on the world? Managing risk and performance aspects? The purpose should lead to the appropriate ESG tool.

		Exclusions	ESG Integration	Active Ownership	Impact Investment
Values	Alignment with values
Influence	Influence company behavior
		Real world impact
Monetary	Risk management
		Outperformance

Negative screening
Professional investors (40% institutions³ and 42% fund selectors⁶ continue to rely on negative screening as part of their strategy, which reflects the large number who say they deploy ESG to better align assets with values. Negative screening, which excludes companies or industries deemed unethical or harmful to society from portfolio consideration, was the cornerstone of ESG’s predecessor, Socially Responsible Investing. But there are limitations to what it can accomplish.

Exclusions may signal good intentions, but the practice may not always deliver the intended results. In truth it can contribute to investment performance – positively or negatively – but the industry has found little evidence that it helps address societal problems or is effective in risk management.

Active ownership
Just over one-third of institutions³ (34%) and fund selectors⁶ (35%) also implement active ownership. In this, the process of leveraging their rights of ownership to influence corporate behavior, professional investors can find dual purpose. On one hand, it has the potential to influence performance on non-financial ESG factors, helping to set a course for more ethical business practices. On the other, it may also be an effective risk management tool and potentially enhance returns. In essence, the practice can contribute to performance, by ensuring that corporations are better managed for the long term and better positioned to withstand systemic transitions.

Impact investing
Most surprising are the 42% of fund selectors⁶ who say they are engaged in impact investing, a number that is considerably higher than their institutional counterparts³ (34%). It may be that selectors are deploying impact funds to meet customer demands, or in the case of family offices, directing assets to support specific client causes. Institutions are likely to consider it in terms of making direct investments in impact projects instead.

By design, impact strategies aim to achieve financial outperformance and/or contribute to solving societal challenges. In general, they can deliver financial performance if they are built on a strong conviction and narrative. They can also contribute to solving societal challenges if the investments finance activities that otherwise would not be financed.

Frequently, though, societal benefits are the exclusive focus. While this is a critical priority, organizers may forget that institutions also have to meet investment objectives. Seven in ten institutions³ say they would be more likely to invest in projects that fulfill sustainable development goals if the investment presented risk/return characteristics that are in line with their objectives.

 

Institutions

 

Fund selectors

		2019 Outlook			2020 Outlook			2021 Outlook
ESG integration		19%	18%		36%	42%		48%	54%
Exclusionary Screening		17%	14%		30%	49%		40%	42%
Active ownership		8%	8%		22%	24%		34%	35%
Impact investing		6%	10%		22%	32%		34%	42%
Best-in-class selection		8%	10%		22%	36%		32%	40%
Thematic investing		3%	6%		18%	33%		28%	43%
We do not implement ESG		39%	35%		36%	33%		28%	23%

 

Institutions

 

Fund selectors

ESG integration	2019 19% 18% 2020 36% 42% 2021 48% 54%
Exclusionary Screening	2019 17% 14% 2020 30% 49% 2021 40% 42%
Active ownership	2019 8% 8% 2020 22% 24% 2021 34% 35%
Impact investing	2019 6% 10% 2020 22% 32% 2021 34% 42%
Best-in-class selection	2019 8% 10% 2020 22% 36% 2021 32% 40%
Thematic investing	2019 3% 6% 2020 18% 33% 2021 28% 43%
We do no implement ESG	2019 39% 35% 2020 36% 33% 2021 28% 23%

Of all the challenges professionals face with ESG, measurement may be the biggest. Even though institutions³ (79%) and fund selectors⁶ (83%) say it’s getting easier to benchmark, the jury is out as to whether they have the tools to measure ESG performance.

Both institutions³ (60%) and selectors⁶ (63%) say third-party ratings and awards make it easier to gauge non-financial performance. The industry has seen greater attention to ESG measurement with services from Sustainalytics,¹² MSCI¹³ and others for benchmarking individual issuers. These are complemented on the funds side with services like those from Morningstar¹⁴ and Barron’s.¹⁵ But professionals are finding that the choices outside of the ratings services are more limited.

 

Institutions

 

Fund selectors

Third-party ratings/awards (e.g. Sustainalytics, MSCI ESG ratings)	60%	63%
Reports from the issuer/company	29%	38%
Non-government organizations (SASB, TCFD, etc.)	28%	22%
Outsourced consultants	24%	23%
News and media	21%	24%
Regulatory filings	13%	28%
It has not become easier to benchmark ESG	21%	17%

In seeking out the data they need, 38% of selectors⁶ and 29% of institutions³ also rely on company and issuer reports. But with a lack of standardized reporting on the corporate side, they may find information can be inconsistent from industry to industry. This makes it harder to set a clear basis for comparison. Beyond these reports, both say they rely on data from non-governmental organizations (NGOs) (28% for institutions³ and 22% for selectors⁶), about one-quarter rely on outsourced consultants, while others rely on news reports and regulatory filings.

Professionals also think asset managers need to do their part as well. Nine out of ten institutions say asset managers should have clear reporting on how they implement ESG. Another 57% think asset managers should be more proactive in developing ESG-labeled funds, while two-thirds also think asset managers should incorporate ESG factors regardless of labeling.³

If a lack of measurement tools challenges professional investors, lack of a common understanding could be the biggest hurdle for retail investors.

Clearly, institutions and fund selectors are driving a big part of the ESG discussion, but that conversation is also playing out between individual investors and their advisors. Our data suggests that unfortunately, they may not always be speaking the same language.

Selectors note ESG efforts are driven by the demands of their end clients: individual investors.⁶ But when it comes to implementing ESG in portfolios, financial advisors and clients are not always on the same page. For example, our 2019 survey of individual investors found the number-one thing investors wanted from their relationship with advisors was to have them offer investments that match their personal values.¹⁶

With 47% asking for this, the issue ranks higher than having advisors clearly explain their fees (45%), listening to them (43%) and helping them manage volatility (42%).¹⁶ But one year later, less than one-third of financial advisors said their clients have been asking for ESG⁷ – even though 81% of investors want to align assets and values.¹⁶

 

Individuals who want investments to align with personal values

 

Financial professionals who say clients have asked about ESG more in the last 12 months

Global	81%	29%
Chile	90%	47%
Colombia	88%	41%
Italy	88%	19%
Hong Kong	87%	16%
Mexico	84%	41%
Canada	84%	21%
Germany	84%	30%
Australia	83%	16%
Spain	82%	37%
Uruguay	80%	20%
US	79%	26%
Switzerland	78%	25%
Singapore	77%	35%
France	76%	22%
UK	72%	42%

Therein lies the challenge. Advisors cover a lot of ground in client relationships, and demand for ESG may be drowned out by the familiar requests. Retirement planning (59%), financial planning (50%) and tax-efficient investments (40%) all rank ahead of ESG in client demand, according to advisors.⁷ Getting a clearer understanding of client preferences may mean reading more between the lines.

Investors may see ESG in more holistic terms, rather than outright asking their advisors to include an ESG fund or two in their portfolio. For example, investors responding to our 2019 survey expressed clear expectations about active ownership.

Three-quarters (76%) expect their fund manager will look at more than the financial aspects of a company in their analysis. Two-thirds (68%) believe their mutual fund manager should be actively engaging with companies. More than half (53%) expect their fund manager to sell investments in companies with poor environmental records.¹⁶

Perhaps most telling of this sentiment is the 50% of investors who go far enough to say the best way to send a company a message is to sell its stock.¹⁶

Ultimately, questions and conversations about these and other issues could go a long way toward helping advisors to better understand what their clients mean by “personal values.” It’s important because clients are confused whether the values alignment is actually happening. When asked outright if they own ESG investments, 16% said they do, but 22% simply said “I don’t know.” ¹⁶

Placed at the intersection of clients who are demanding more ESG investments and the firms trying to deliver, financial advisors are uncertain about how it will all play out. Seven in ten say that with an increasing number of these strategies available, it is hard to know which ones may deliver on both investment performance and ESG performance.

Like institutional investors, they identify reporting as a critical factor for gaining buy-in on ESG. 73% say standardized reporting will increase ESG adoption, and 66% say it’s hard to know which measures of non-financial performance actually matters. When it comes down to it, 58% say they would implement more ESG strategies if there was an easier way to do it. ⁷

There’s no question that ESG received significant interest from all sides of the investment ecosystem in 2020 based on the survey data in this report. But those predicting an ESG bubble may not see the full picture. Is it possible that some of the companies that benefited from the focus on sustainability experienced unwarranted growth? Certainly. Is it possible there has been a rush in the industry to capitalize on a new investment trend? Maybe. But the underlying factors driving growth seem more likely to continue.

Regulators across the globe continue to press asset owners and asset managers to factor sustainability issues into their investments. Individuals continue to demonstrate increased demand for ESG based on a wide range of reasons. And we are seeing the investment industry respond.

Professional investors are clarifying their motives for implementing ESG. In many cases this is not a simple black and white decision: Organizationally, large numbers of institutions and wealth managers are trying to contribute to a better world – or at least trying to align their assets with their values. Financially, many are also looking to become better investors by integrating ESG into their investment process and actively engaging with the companies in which they invest.

In the end, as long as society faces environmental and social challenges and as long as the demand continues for greater transparency for businesses, the odds are good that investors will want these considerations factored into their portfolio.

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